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Analysis
Brussels compromises likely to unravel

Brussels compromises likely to unravel

Merkel euro deal faces more lawsuits
Constitutional Court and Bundestag called in again

by David Marsh, OMFIF Chairman

Mon 2 Jul 2012

Out of the frying pan, into the fire. Chancellor Angela Merkel ran into a hail of criticism after arriving back in Berlin from her Brussels summit sojourn.

The major German concessions (above all, over use of ESM European rescue funds directly for Spanish banking recapitalisation) agreed at the euro summit on Friday are unlikely to enter into full force. The compromises between creditors and debtors are doomed to unravel because they are mutually contradictory.

The European Central Bank is, however, out of the firing line for the moment. It can cut interest rates by ¼ percentage point on Thursday without being accused of kowtowing to government pressure. ECB bond purchases, hotly opposed by the Germans and a steadily-growing band of other countries, are off the agenda as the focus switches to taxpayer-backed rescue devices.

However, these taxpayers, and their parliamentary representatives, are about to revolt. A fierce political and constitutional battle lies ahead. Whatever happens, the outcome is likely to weaken Chancellor Merkel. She will conclude that attack is the best form of defence, and come out fighting.

In Brussels, Merkel was forced into an embarrassing climb-down on directly injecting taxpayers’ funds into ailing banks by an unholy coalition of opposing interests who blackmailed her into submission. She was caught in a pincer movement – something she will not easily forget.

The Social Democratic and Green Opposition parties in Berlin told her on Thursday they wouldn't vote for the European fiscal pact and ESM in the Bundestag on Friday, the last day before the German summer parliamentary recess, unless Merkel agreed a ‘growth pact’ in Brussels. Aware of this, Spanish and Italian prime ministers Mariano Rajoy and Mario Monti sprung a trap, backed by French president François Hollande.

A direct squaring-off between Merkel and the leaders of the other three big EMU economies has not happened before. As a reaction, a new German alliance to back a hard line on the euro is starting to gain ground, linking conservatives who have never been too keen on EMU, and business leaders who up to now have been very keen on it.

Late on Thursday, Monti and Rajoy refused to agree the growth pact unless Merkel made concessions on aid for banks and on conditions for direct bond purchases by the EFSF and ESM bail-out funds. Hollande denied Merkel was bludgeoned into an agreement. But she was. All this will create further resentment in Germany.

The Brussels decisions sound sensible. They ostensibly break through the vicious circle of money for Spanish banks adding to Spanish government debt, increasing borrowing costs, dragging down the economy, adding to government deficits, forcing local banks to buy government debt, exacerbating the banks' problems, creating the need for more bail-outs.... And so on.

However, the decisions counter solemn assurances given by Merkel to protect German taxpayers. They will run into very large political and constitutional difficulties. Better terms for Spain, Italy and Ireland will toughen the Greeks’ demands for their own concessions.

Greece has left the radar screen for the time being, because of new Prime Minister Antonis Samaras' absence from Brussels. Merkel did not mention Greece once in her parliamentary declaration on 27 June. But Greece will be back with a vengeance. This will not be conducive to euro harmony.

The Bundestag vote on Friday night on the fiscal pact and ESM was a farce. It laid down that ESM money would go to the governments, not the banks, and would be conditional on Troika-style packages. The legal documentation was overtaken by events, because Merkel had agreed diametrically different terms in Brussels.

As Sigmar Gabriel, the SPD leader said, the agreement to recapitalise the banks directly (which he personally backed) ‘is the opposite of what we are about to decide.’ So the Bundestag decision to back the ESM on Friday night was more or less irrelevant.
The vote was not postponed, which would have been sensible, to avoid frightening the markets. But the Bundestag will have to vote again when what was agreed in Brussels becomes more concrete in coming months (perhaps not until next year).

The ESM is anyway not operational (despite the parliamentary Yes) because the new law has not been signed by President Joachim Gauck. He is withholding consent because the German Constitutional Court is still examining a range of objections by various plaintiffs.

Additional lawsuits were submitted to the Court late Friday under various fast-track procedures. They include a formidable 123 page document drawn up by the doughty Prof. Karl Albrecht Schachtschneider, at the helm of a group of professors who have been bringing lawsuits for two decades to inject more parliamentary and democratic oversight into EMU.

Examining these will take at least three weeks. Merkel's latest surrender underpins claims that European actions contravene some basic German parliamentary principles.

The Court is very unlikely simply to veto the latest moves – although the plaintiffs are hoping for an injunction. But Merkel’s U-turn greatly increases the chances that the Court will subject ESM aid to draconian parliamentary control.

On top of all this, direct banking recapitalisation will come into force only when the ECB takes over supervisory arrangements, changing the present set-up with the European Banking Authority.

In particular, an agreement will be needed with non-euro area financial centres, especially the UK. This will not be easy, as the new groundswell of anti-EU sentiment in Britain makes clear. Winning accord and implementing the changeover process will probably extend well beyond the end of the year.

Pooling supervision at the ECB is hardly a new idea. It makes use of clauses contained in the Maastricht treaty of 1991-92 and was suggested as long ago as May 2007 by Alexandre Lamfalussy, former president of the European Monetary Institute (the ECB forerunner).

Separate elements of the Brussels compromise may make sense, but the sum total will not see the light of day, because the separate components do not add up, economically or politically. So watch out for much more drama ahead.

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